Reflecting on the MPS and the Reserve Bank

There were some aspects of Graeme Wheeler’s comments following the release of the Monetary Policy Statement the other day that I welcomed.

He firmly pointed out that no advanced country central bank – or, more importantly, government – had abandoned inflation targeting since the global recession of 2008/09, and that none had lowered (or raised in fact) their inflation targets. It is always worth keeping an open mind on possible improvements to the regime – inflation targeting centred on 2 per cent won’t be the end of history – but for now the Reserve Bank’s job, given to it by the government, is to get and keep inflation outcomes, over the medium-term, around the 2 per cent midpoint of the target range.

And when asked about the impact of a lower OCR on house prices, he succinctly observed “well, that’s just something we’ll have to watch”. By conscious choice, house prices are not part of the inflation target, either in New Zealand or in most (if not all) inflation targeting countries. It is one, important, relative price, influenced heavily by a range of other policy considerations. And if bank supervisors should pay a lot of attention to house prices, and associated credit risks, it is a different matter for monetary policymakers.

And, of course, there was the OCR cut itself. It was the right thing to do, and on this occasion he didn’t allow himself to be locked in by his own previous rhetoric. Probably one reason why I was less surprised by the move last Thursday than some of my fellow doves is that I’ve seen – and been part of – too many episodes in the past when the Reserve Bank has flip-flopped, and when speeches and statements had either backfired or been ill-considered in the first place.

The Reserve Bank now seems to be trying to make out that no one should have been surprised, and that there was nothing wrong with the Governor’s February speech (made only five weeks before the MPS). Shamubeel Eaqub tells us that

An official told me it was this document that signalled the requirements for a cut in the March meeting

At one level, this is clearly nonsense. His markets and economics people will have pointed out to him that few people expected a cut last Thursday, whether or not they thought one was warranted. He knew he was going to deliver a surprise.

At another, and more important, level it is also nonsense. Of course, the February speech had the usual lines about risks and the way in which if the outlook changed so would the policy rate path. Central bank speeches always do.

But (a) the Governor knows very well that his speech (not that of an underling, but of the decision maker himself) was interpreted hawkishly, and (b) that readers who interpreted it that way were quite reasonable to have done so. After all, if he had thought everyone misinterpreted it on 3 February, it would have been very easy for the Bank to have corrected the perception – journalists are always keen to talk to the Governor, although only the Herald ever seems so favoured.

In many respects it was an elaboration on last week’s brief OCR review statement – “we might have to cut the OCR, and risks are tilted to the downside, but we don’t really want to”.

…Once again, the Governor simply does not seriously engage with the arguments made by those who suggest that a lower OCR would have been, and would be, preferable. Instead, he basically makes up an inflation story that simply isn’t supported by the numbers, and attacks straw men. The defensiveness is disheartening.

There were his assertions that core inflation was just fine, that inflation expectations were just fine (even though he knew key data were coming out shortly which were likely to move lower), that the OCR increases of 2014 had been fully reversed (without so much as a hint of a mention of real interest rates), that the economy was doing well, and house price inflation was concerning, all the time attacking those nameless critics with their “mechanistic approach” suggesting that lower headline inflation warranted a lower OCR. It just wasn’t a speech that a capable Governor would have given had he thought there was a reasonable chance that he might be cutting the OCR only five weeks later. Like others, I’ve gone back and read the speech since Thursday, and I stand by that conclusion. The underlying economic and inflation position just did not change that much in the intervening few weeks.

I didn’t lose money on the episode, or have clients who did, so this isn’t just an articulation of the pain of getting it wrong and hearing from upset clients. It was simply a(nother) poor performance from the Bank.

I’ve had people ask whether I think it is a case of the Governor not really being up to the job, or of him simply being poorly-advised. Russian peasants, languishing in their oppression, are said to have reassured themselves “but if only the Tsar knew, if our plight were not kept from him by the venal or incompetent advisers”.

It is easy to adopt the “poorly advised” line, but I don’t think it really washes. Apart from anything else, the Governor has been in place now for 3.5 years and his senior advisers are appointed, appraised, and rewarded by him. Part of the chief executive’s role is to have robust advisory processes in place, including people who are willing to stand up and point out the risks in what he is saying or doing. But, in any case, in my experience at the Bank the Governor treated speeches as very much his own product- drafted by him, and not really receptive to any suggestions or comments that challenged his own priors. The February speech felt at the time like the work of an embattled defensive individual, over-reacting under pressure. Subsequent events tend to confirm it. The MPS has a very very different tone to it than the speech. And as I noted the other day there is no sign in it of the staff sharing the Governor’s predilection for the sectoral core factor model as a best single measure of inflation – indeed, the text and chosen chart almost looked as if they had been placed to undermine any such suggestion.

At one level, perhaps it doesn’t matter very much. In the end, the speech wasn’t an OCR review, and when it came to reviewing the OCR he did the right thing. While I don’t think it is desirable to set out to surprise markets, neither do I think that such surprises in and of themselves are the worst thing in the world.

But it is symptomatic of a weak institution. In one sense, the weakness isn’t new or specific to Graeme Wheeler. I’d argue that for 20 years the Reserve Bank has been prone to lurches, and has lacked the solidity and consistency of some of better central banks around – including notably the Reserve Bank of Australia. Some of the worst examples – eg (for those with long memories) the MCI – occurred on the watch of my friend Don Brash. But things have got materially worse again in the last few years.

In his interview this morning, Liam Dann includes this curious impression

You get a sense Wheeler enjoys lively debate and would love to engage more in the local discussion.

It isn’t an impression anyone else I’m aware of has of him. While I was still at the Bank he very resistant to any internal debate or to dissenting views – and from what I hear on the grapevine that hasn’t changed in the last year. His speeches give no sign of an enthusiasm to engage with alternative perspectives, or even to recognize that such perspectives might have any merit (nameless critics dismissed as “mechanistic”). And as others have pointed out – a couple of soft-soap Herald interviews apart – he does no serious local interviews, and thus eschews the ample opportunity he has to be part of the local discussion. Curiously, despite being the head of a New Zealand government agency, paid in effect by the people of New Zealand, Wheeler comments to Dann that when he answers media questions his main interest is “economists and investors in the United States or Europe”. He spent much of his working life in the US and Europe, behind the scenes, and there is nothing to suggest he is remotely comfortable in the glare of public scrutiny back home.

Add in a continued reluctance to ever acknowledge having made mistakes (in an area where mistakes are inevitable, at least for humans), the making up on the fly of ill-supported stories (eg “it was all about petrol prices” only six weeks ago, a line that has now disappeared again), a continued failure to get or keep inflation near target, and communications failures like the February speech, and it all adds up to much less than we deserve from such a powerful agency and its chief executive. He doesn’t seem to have either the really superior personal insights on the economy, or the self-confidence (and recognition of his own limitations) to foster the dialogue and debate internally, that would help deliver consistently good policy, and supporting analysis.

It is good that he cut the OCR on Thursday. It was overdue. But it is not as if the problems have gone away. He still seems oblivious to the increases in real interest rates he has overseen, he is still defending the February speech (in the press conference he again asserted that he had to deal with – nameless – critics misinterpreting the PTA), in his press statement (the bit of the MPS he focuses on most) he still asserts the centrality of the sectoral factor model measure when the rest of the document largely ignores it. And he still forecasts that inflation will get back to target, but offers little substantial analysis to support his claim. I do believe that he cares about persistently low inflation, but in his role performance is really what matters. We still aren’t seeing it, and there is nothing in the content or processes to suggest we will avoid a repeat of the last 12 months, heel-dragging and ill-considered communications, in the period ahead. That has to be a concern. Under the governance model, the Board’s Annual Report this year should be interesting, It probably won’t be.

Rod Oram wrote yesterday that

Our Reserve Bank was once a global leader. It must be again.

When he arrived at the Bank, Graeme Wheeler had the mantra of making the Reserve Bank the best small central bank in the world. I was never sure that was realistic- after all, a lot of countries choose to devote a lot more resources to their central bank than we do (even the Governor the other day somewhat surprisingly acknowledged to FEC that it would help if he had more resources). So, I also don’t think we can expect our central bank to be a “global leader”.

But it really should be doing quite a lot better than it is.

Finally, just a note on one other observation from the Dann interview. In an unusual disclosure, the Governor tells us that all the 13 people who provided him with written advice on the OCR decision favoured a cut last week, leaving Dann with the impression that “it wasn’t even a line-ball call”.

It is, probably, good to know that officials were unanimous in their advice. But

if those 13 people had seen the draft of the January speech were they all unanimous in being comfortable with that?

it is worth bearing in mind that, in my long experience on the Monetary Policy Committee(or its predecessor the OCR Advisory Group), overwhelming majority “votes” are much more common than material divisions of opinion. It is a climate that does not encourage debate, and certainly does not encourage significant differences of opinion at the recommendation stage. Indeed, I recall the meeting at which Deputy Governor Geoff Bascand, admittedly then new to the Bank, laid into me for an OCR recommendation which he most certainly disagreed with. It takes a certain strong-mindedness (or sheer stupidity) to go on dissenting.

It was an unusual disclosure because the Bank has always fought hard to keep secret the advice provided to the Governor on the OCR. But if the Governor has chosen to disclose the “vote” on this occasion, only a few days after the announcement, it is difficult to see how any of the usual OIA excuses (“free and frank expression of opinion”, “substantial economic damage to the interests of New Zealand”, or “avoiding premature disclosure”)can now be applied in future, especially in respect of decisions from some quarters past. I have just lodged an OIA request for the voting record (aggregate only, no names, thus mirroring Wheeler’s disclosure) for all OCR decisions since mid-2013 (ie just prior to the ill-fated tightening cycle getting underway).

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5 thoughts on “Reflecting on the MPS and the Reserve Bank”

The country’s economists have been both upgrading their economic growth forecasts – and downgrading their expectations of inflation.

At the same time, there’s another caution from the Reserve Bank that falling inflation expectations might lead to further rethinking of interest rate levels.

The latest NZIER Consensus Forecasts show that on average economists now see GDP pushing up to 2.6% for the year to March 2017, rising to 3% in the March 2018 year and easing back to 2.5% in 2019. This compares with forecasts in December of 2.5%, 2.7% and 2.3% for the same periods.

But at the same time, the economists picks for inflation have dropped sharply. In December they were picking an annual inflation rate of 1.3% for the March 2016 year – but now they are picking just 0.4%. The average prediction for the March 2017 year has also fallen significantly to 1.6% from 1.9% – but the picks for subsequent years are largely unchanged.

Lowe and Ray also drew attention to the lingering decline in Australia’s national income.

In past decades economic growth and national income have been very closely correlated but since the mining boom the two have diverged.

As a result the key measure of the economy – gross domestic product – has continued to grow but net national disposable income per capita – a key measure of living standards – has stalled.

Average real income is no higher today than it was in 2008.

“It means that as a nation, we’re working hard but not getting paid as much as we used to for what we produce,” Oliver said.
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Starting to sound familiar. Talking about the Aussie economy. Add America, Japan and so on and you start to get a picture of the future.

When Fonterra announced a payout at $3.90 and that potentially 44% of farms was potentially in breach of their banking covenants, I do not think that a cut would be surprising to anyone. Not too sure why it would be a surprise to various banking economists.

Wheeler has certainly done a better job than Bollard. Under Wheeler the economy has been consistently bouyant. Bollard actually drove the economy into a deep long recession. His savings grace was his quick reaction drop in the OCR. But he should never have pushed it up to 9% in the first place.